Timing Considerations for Expatriation, Tax Compliance and Form 8854

I invite readers to enjoy my article, copied below, recently published by Bloomberg Tax in the Daily Tax Report.  Reproduced with permission. Published January 7, 2022. The Bureau of National Affairs, Inc. (800-372-1033) www.bloombergindustry.com It is online here.   My blog post today contains additional input with a link to a podcast on this topic with US and Canadian attorney John Richardson. Here you go!

As a tax practitioner assisting many taxpayers with expatriation issues for decades, I sometimes see a question arise in cases when the taxpayer has not sought my advice prior to expatriating – for example, before renouncing US citizenship or surrendering a green card held for at least 8 tax years.   The question is when must an individual meet the full “tax compliance test” under IRC 877(a)(2)(C) in order to avoid “covered expatriate” (CE) status? Is it at the time of expatriation (i.e., renunciation of citizenship or surrender of green card), or, at the time the final tax return together with Form 8854 is signed?

US Expatriation Tax Rules in a Nutshell

The US “expatriation tax” provision rules apply only to certain US citizens or long-term residents who have given up their U.S. status. Long-term residents are generally those holding a green card for eight of the past 15 years and have properly ended their U.S. resident status for tax purposes.

Under the expatriation rules contained in IRC Section 877(a)(2) an individual will be treated as a CE if any one of the following tests applies (quoting the statutory text):

• (A) the average annual net income tax (as defined in section 38(c)(1)) of such individual for the period of 5 taxable years ending before the date of the loss of United States citizenship is greater than $124,000 [VLJ Notes: US$172,000 for 2021. This means income tax paid by the individual, not his or her income],
• (B) the net worth of the individual as of such date is $2,000,000 or more, or
• (C) such individual fails to certify under penalty of perjury that he has met the requirements of this title for the 5 preceding taxable years or fails to submit such evidence of such compliance as the Secretary may require.

If any one of these tests is triggered, the individual is a CE.  A CE is subject to the “Exit Tax” or “Mark-to-Market” regime which generally means that all property owned by the CE worldwide is treated as sold for its fair market value on the day before the expatriation date.  This “pretend” gain is then taken into account for the tax year of the deemed sale and subject to tax, usually at capital gains rates. An exception for a certain amount of gain (which is adjusted annually for inflation) is provided in the tax law. On account of this exception, some individuals may not be impacted by the “Exit Tax”, but the exception is calculated a very specific way and professional guidance should be taken. Special tax rules apply, for example, to certain deferred compensation items and to trust distributions; the exception for a certain amount of gain does not apply to these items.

In short, it’s complicated!  Get the best tax advice.

In addition to the Exit Tax, US recipients of any gift or bequest at any time in the future from the CE must pay a special transfer tax—currently 40% of the value of the gift or inheritance.

Full “Tax Compliance”

So, back to the question! Assuming the taxpayer does not trigger either the net worth or tax liability test, when must he be fully tax compliant? If he is not tax compliant at the time of expatriating, but later achieves full compliance by the due date of the final tax return with the accompanying Form 8854 (signed under penalty of perjury and checking the “yes” box to Part II Question 6) is this sufficient to prevent CE status?

The Scoop

As a tax practitioner, what I always try to do is avoid potential issues and have the individual  be fully tax compliant at the time he takes the oath of renunciation (or surrenders the green card).  Sometimes, however, before coming to see me, the individual has already expatriated or given up the green card but is not fully tax compliant.  Full tax compliance is achieved, however, before the due date of the final return and Form 8854 (which are timely filed and signed under penalty of perjury). It appears to me one can take the position and argue that the taxpayer should not be treated as a CE in such an instance.

First, the law does not specifically state when the individual must be fully tax compliant (although the statutory language “fails to certify under penalty of perjury” in IRC Section 877(a)(2) arguably indicates compliance must be met at the time the taxpayer so certifies). No Treasury Regulations have been issued to date clarifying the law. Second, twelve years ago, the Internal Revenue Service (IRS) issued IRS Notice 2009–85 (“Notice”) which is the only official expatriation guidance currently available.   The Notice itself does not make clear when full tax compliance is required. I have provided relevant excerpts from the Notice at the very end of this post.

Deep Dive into IRC Section 877(a)(2)(C)

Taking a deep dive into the text of the statute itself, one can see that it is simply not possible to meet the tax compliance certification test if it is interpreted to mean a taxpayer must be fully tax compliant as of the expatriation date. Remember the statute requires compliance “for the 5 preceding taxable years.”  (although the Notice and Form 8854 apparently use 5 preceding calendar years).

Here is an example: Taxpayer expatriated on January 25, 2021 taking the oath of renunciation on that date. The 5 preceding “taxable years” are: the short taxable year January 1, 2021-January 24, 2021 and the full calendar years 2017-2020.  Taxpayer’s final income tax return for 2021 will be a so-called dual status tax return, reflecting his US and non-US status (generally it is due June 15, 2022). It is impossible for him to file the short-year tax return by the expatriation date of  January 25, 2021. Additionally, the Taxpayer cannot be compliant on that date with respect to tax year 2020 since the tax season did not start and it is impossible for him to file the 2020 tax return.  The only date that makes any sense whatsoever for certifying tax compliance, is the date the taxpayer signs the Form 8854.

Additional Arguments

First, the statute does not specifically state when the individual must be tax compliant, although the statutory language “fails to certify under penalty of perjury” arguably indicates compliance must be met at the time the taxpayer so certifies. No Treasury Regulations have ever been issued.

Second, 12 years ago, the IRS issued Notice 2009–85, which is the only official expatriation guidance currently available. The Notice itself does not make clear when full tax compliance is required—see Sections 2A and 8C of the Notice. [Excerpts from the Notice are at the end of this blog post].

I had occasion some years back to informally speak to Bill Yates, the IRS attorney who was a principal author of Notice 2009–85. His view is that the Notice should be interpreted to mean tax compliance must be met on the expatriation date. I pointed out to him that the Notice and Form 8854 and its instructions do not clearly say that. By comparison, the tax law and Form 8854 are quite clear about when to measure the value of the taxpayer’s assets—the day before expatriation. On the certification test, neither the law nor the IRS is explicit.

By analogy, one can look to the normal income tax return—how does the taxpayer certify under penalty of perjury that everything is accurate? As of what moment is the taxpayer making that certification? Clearly, the answer is at the time the taxpayer signs the tax return. The tax compliance certification can be similarly viewed—the relevant point for full compliance is when Form 8854 is signed.

I would also point out that the IRS currently has certain relief procedures in place to help individuals who fail to file Form 8854 and expatriate—even those with a US tax filing history—as well as those who failed to file Form 8854 and are not fully tax compliant. If a taxpayer can use the procedure, it will mean relief from toxic CE status and its very harsh tax consequences.

If the tax law was abundantly clear on the issue that full tax compliance had to be met as of the date of expatriation, these IRS Relief Procedures would be beyond the permissible scope of the statute. However, the law is not clear. These Procedures confirm it and indicate that the IRS itself does not have a fixed and clear stance on the issue.

As many are aware, expatriation is a hot area for IRS audits, and since June 2019, it has been an active IRS “compliance campaign.” I understand from reputable tax colleagues that expatriation audits have been happening, with the IRS taking the position that tax compliance must be met at the time of expatriation.

This area of tax law is a mess, and maybe it will be resolved only through litigation.

* * * *

If you are thinking of expatriating, are in the process, or have already taken the plunge but have certain tax concerns, you need a top notch tax professional with the right experience. Contact me for assistance.

You can listen to a podcast on this topic in which I discuss the issue with US and Canadian attorney John Richardson.   John and I have worked together on numerous cases. His professional practice focuses on assisting US citizens and green card holders who live outside the United States who face unique issues such as the one involved in the subject of this post.

Relevant excerpts from the Notice 2009-85:

SECTION 2. INDIVIDUALS COVERED

A. Definitions

Covered expatriate. Section 877A (g) (1) (A) defines the term “covered expatriate” to mean an expatriate who:

• …. (3) fails to certify, under penalties of perjury, compliance with all U.S. Federal tax obligations for the five taxable years preceding the taxable year that includes the expatriation date, including, but not  limited to, obligations to file income tax, employment tax, gift tax, and information returns, if applicable, and obligations to pay all relevant tax liabilities, interest, and penalties (the “certification test”). This certification must be made on Form 8854 and must be filed by the due date of the taxpayer’s Federal income tax return for the taxable year that includes the day before the expatriation date. See section 8 of this notice for information concerning Form 8854.

Section 8 C of the Notice:

Form 8854

Certification of compliance  with tax obligations for preceding five years. All U.S. citizens who relinquish their U.S. citizenship and all long-term residents who cease to be lawful permanent residents of the United States (within the meaning of section 7701 (b) (6)) must file Form 8854 in order to certify, under penalties of perjury, that they have been in compliance with all federal tax laws during the five years preceding the year of expatriation. Individuals who fail to make such certification will be treated as covered expatriates within the meaning of section 877A (g) whether or not they also meet the tax liability test or the net worth test. For more information about the tax liability test, the net worth test, and the certification test, see section 2 of this notice.
…
Time and manner of filing initial Form 8854. A covered expatriate must file Form 8854 with the covered expatriate’s Form 1040NR or Form 1040, whichever is applicable, for the covered expatriate’s taxable year that includes the day before the expatriation date. A covered expatriate who is required to file Form 8854 for such taxable year will be considered to have timely filed Form 8854 if it is filed by the due date of the original Form 1040NR or Form 1040 (including extensions) for such taxable year. Covered expatriates who are U.S. citizens or long-term residents for only part of the taxable year that includes the day before the expatriation date must file a dual-status return. See section 8.B of this notice.

Posted January 13, 2022

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